Reality as Told by the Trader, Part 2

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Editor's note: This is the second installment in a multipart series. Please check out Part 1 and look for Parts 3 and 4 later today!

The second fortuitous event came when a couple of dot-coms came public at wild valuations. We had some publicly traded dot-coms, and they were outrageously overvalued, but there were not enough of them to do anything other than create a little wave of speculation in the system. But the premiums to which these November 1998 dot-coms reached when they opened changed everything. That stretched severely our ability to value anything because the valuations that we saw at the opening of trading defied anything we had ever seen.

We began to believe that the dot-com world would have its own set of valuations, and any company that got involved or aided and abetted dot-coms in any way, shape or form would be valued similarly. That meant scrapping traditional price-to-earnings multiples. It meant using price-to-revenue analysis.

The bankers had to use this new calculus because they had no other rationale. They couldn't use traditional measurements because it meant selling companies publicly for a fraction of what managements could get in the open market. (That was the embarrassment of the first few deals; it had to be avoided in the future.) But they couldn't price the stocks at the outrageous multiples the market was willing to pay at the opening because those were clearly unsustainable and would come back to haunt the underwriters.

So they settled on some in-between methodology that suited no one but at least had some rigor, some grounding, an outrageous multiple to revenue of the existing comparable New Economy plays. It pleased no one, but protected them from the inevitable lawsuits that would develop if they priced the stocks where the market was telling them to.

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James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund had no positions in any stocks mentioned. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to send comments on his column to James J. Cramer .